Aggregate Idiosyncratic Risk and Market Returns
Journal of Investment Management, Vol. 4, No. 4, Fourth Quarter 2006
Posted: 29 Nov 2006
This paper tests the empirical performance of a model-independent measure of aggregate idiosyncratic risk introduced by Bali and Cakici (2004) in ICAPM framework. The results indicate a significantly positive relation between the equal-weighted average stock volatility and the value-weighted portfolio returns on the NYSE/AMEX/Nasdaq stocks for the sample period of 1963:08-1999:12. We show that this result is driven by small stocks traded on the NASDAQ. In addition, the positive risk-return tradeoff does not exist for the extended sample of 1963:08-2004:12 and for portfolios of NYSE/AMEX and NYSE stocks. More importantly, we find almost no evidence of a significant link between the value-weighted portfolio returns and various measures of the value-weighted average idiosyncratic volatility.
Keywords: Idiosyncratic Risk, total risk, average stock risk, stock market volatility, stock returns
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